Statutory Earnings May Not Be The Best Way To Understand Nippon Pigment Holdings' (TSE:4119) True Position

Despite posting strong earnings, Nippon Pigment Holdings Company Limited's (TSE:4119) stock didn't move much over the last week. We looked deeper into the numbers and found that shareholders might be concerned with some underlying weaknesses.

Check out our latest analysis for Nippon Pigment Holdings

Zooming In On Nippon Pigment Holdings' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to September 2024, Nippon Pigment Holdings had an accrual ratio of 0.36. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Over the last year it actually had negative free cash flow of JP¥213m, in contrast to the aforementioned profit of JP¥7.37b. We saw that FCF was JP¥1.2b a year ago though, so Nippon Pigment Holdings has at least been able to generate positive FCF in the past. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio. One positive for Nippon Pigment Holdings shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Nippon Pigment Holdings.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Nippon Pigment Holdings' profit was boosted by unusual items worth JP¥7.4b in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. We can see that Nippon Pigment Holdings' positive unusual items were quite significant relative to its profit in the year to September 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Nippon Pigment Holdings' Profit Performance

Nippon Pigment Holdings had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Nippon Pigment Holdings' profits probably give an overly generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To that end, you should learn about the 4 warning signs we've spotted with Nippon Pigment Holdings (including 1 which makes us a bit uncomfortable).

Our examination of Nippon Pigment Holdings has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.